The latest federal budget is treating a well-used small-business tax loophole like a pothole – something that needs to be filled.
The goal is to stop partnerships of doctors and other professionals from claiming multiple small-business tax deductions. Or, as the budget argues, limiting the ability of "high-net-worth individuals to use private corporations to inappropriately reduce or defer tax."
But one person's perceived tax loophole is another person's business model.
Take William Miller. He is a neuroradiologist, president of the Canadian Association of Radiologists and an assistant professor at the University of Ottawa. He works within a partnership of radiologists in the Ottawa and Eastern Quebec region called the Ottawa Hospital and Region Imaging Associates.
The partnership is like any other professional, small-business partnership: Clients, i.e. hospitals, can hire from a range of specialists, in this case radiologists. The partnership in turn provides the doctors with a client base and pooled income, which provides equal pay. (Some specialties pay more, some pay less. This lets all specialists enjoy equal pay within the group, Dr. Miller explained.)
Yet one of the rule changes in the new budget is to prevent partners from charging fees to the partnership for services they provide. In other words, partners who incorporate themselves can each claim the small-business tax deduction when charging the larger partnership for their services. The new federal budget proposes to curtail this, the argument being that this exploits small-business tax rules. It's a case of too many partners all claiming the deduction within a single partnership, the government says.
Dr. Miller argues that the new rule would be a financial disincentive to stay within the partnership. Doctors will be persuaded to remain individually incorporated, keep the power to claim the small-business tax deduction and simply go it alone as independent practitioners, rather than to stay in the partnership and lose the deduction.
He points out that the partnership also serves other purposes, notably helping to pay for education and research, including supporting doctors doing their residencies and fellows as they take on specialty training. "It would be very hard to do [this] if we weren't a group. It would be impossible," Dr. Miller said.
With the new rule, "if I work in a group, I would pay a financial penalty. Whereas if I go work solo, in a clinic somewhere, I have an incentive to do that. And that doesn't support comprehensive care delivery, that doesn't support the ability to provide education or research," Dr. Miller said.
The counterargument is that multiple partners, all receiving small-business deductions, as is the case now, isn't in the spirit of the original tax rules. As the latest budget says, the new rule is to "prevent business owners from multiplying access to the ... small business deduction using complex partnership and corporate structures."
Canada's basic small-business tax deduction is also not expected to ease, as some had hoped. Despite indications that the government would reduce the tax rate for the first $500,000 of small-business earnings, the new Liberal government has frozen it instead at 10.5 per cent. The previous government had promised to gradually reduce the rate to 9 per cent by 2019. The Liberal budget proposes that the plan be "deferred."
Instead, the budget zeroes in on perceived loopholes. The expectation is that partnerships will have to consider alternative corporate structures to keep their business model intact.
However, "the challenge right now is that the final legislation isn't released," said Gavin Miranda, regional tax leader at the accounting firm MNP LLP in Ottawa. "There are alternatives that we've already come up with, [but] we are waiting to see what the final legislation looks like to see if these would be viable."
Another rule change similarly restricts tax deductions among associated companies. It is a relatively arcane rule, said tax specialists at MNP, affecting only specific types of business setups. Generally, it concerns companies associated with one another that are converting passive income (such as interest income from loans or rental income) into active business income. That loophole will be closed.
The budget says it's to "ensure that investment income derived from an associated corporation's active business is ineligible for the small-business deduction (and taxed at the general corporate income tax rate) in certain circumstances."
Yet it's the professional partnership rule change that is expected to have the widest effect. "There are other large groups of professionals that will be impacted by this measure," Dr. Miller argued.
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